Can FHFA Save the Mortgage Market?

Mel Watt, the new director of the Federal Housing Finance Agency, announced last week that the agency will take a more proactive approach toward healing the housing market.

This decision could not have come soon enough.

Now that homeowners are not refinancing their mortgages as much as they were last year, when interest rates were lower, mortgage originations are at historic lows. Total home sales, however, have not dropped as precipitously simply because in the first quarter of this year, cash buyers made 43 percent of all home purchases—compared with less than 20 percent in 2001.

What’s more, nearly half of all mortgages made today go to borrowers with credit scores of more than 750. By way of comparison, in 2001, before Fannie Mae and Freddie Mac purchased the risky loans that damaged their financial health, more than two-thirds of mortgages went to borrowers with scores lower than 750. The Urban Institute estimates that, primarily due to tight credit, as many as 1.2 million loans that would have been made in 2001 appear to be “missing” from today’s market.

The fallout from the housing crisis disproportionately affects first-time homebuyers and borrowers of color. Not only were borrowers of color disproportionally targeted by subprime lenders—resulting in massive wealth stripping from which it may take generations to recover—but they are now almost entirely shut out from the conventional mortgage market. Homeownership rates for young people ages 25 to 34 are among the lowest in decades, raising concerns about whether Millennials can build wealth and whether aging Baby Boomers will have buyers to whom they can sell when they are ready to downsize.

In short, unless lenders find a way to extend credit to qualified borrowers currently shut out of the housing market, we aren’t likely to see a full housing recovery anytime soon.

Watt announced that his agency will address systemic challenges that lenders say are keeping them from making the loans that Fannie Mae and Freddie Mac want to buy. Lenders claim that uncertainty over “put backs”—when Fannie or Freddie ask a lender to repurchase a loan that has gone bad—is keeping them from making loans. The regulator says it will work with the industry to address this uncertainty so that banks have a better understanding of the conditions under which Fannie Mae or Freddie Mac could require a repurchase.

The FHFA strategic plan also calls for the agency to complete two rulemakings that can help expand access to credit. One is the “duty to serve” provision in the Housing and Economic Recovery Act of 2008, which requires FHFA to ensure that Fannie and Freddie provide leadership in supporting low- and moderate-income families in manufactured housing markets, affordable housing preservation, and rural markets. The agency issued a proposed rule in 2010 but has never finalized or implemented the rule.

The second is the upcoming rulemaking for the affordable housing goals, which require updating for 2015. These are annual numeric targets that FHFA sets for Fannie and Freddie to buy loans that were made to creditworthy low- and moderate-income borrowers and borrowers in traditionally underserved areas. Both of these rulemakings provide FHFA with an opportunity to ensure that Fannie Mae and Freddie Mac are serving a broader and more diverse market.

Some commentators suggest that any loosening of the “credit box”—the credit parameters within which banks will lend—constitutes a return to the unsafe lending of the boom years. This claim is simply not true.

In the lead up to the financial crisis, Wall Street’s appetite for high-yield mortgage-backed securities drove mortgage lenders to push millions of borrowers into predatory loans with poor underwriting and with risky features, such as steep resets or negative amortization, and with prepayment penalties that locked borrowers into these toxic products. While some of these loans had low down payments or went to borrowers with lower credit scores, it was the layering of numerous risks that caused them to fail.

What’s more, if anyone knows the perils of risky lending, it’s Watt. During the boom years, many members of Congress assumed if profits were high, then the mortgage market must be doing well. However, then-Rep. Watt (D-NC) and his North Carolina colleague, Rep. Brad Miller (D), warned that predatory practices were undermining the health of the market, proposing legislation that would have eradicated these practices long before they ended up bringing down the financial system.

Since the crisis, Congress has enacted new mortgage laws to make sure that consumers are protected from these types of products in the future. Moreover, studies confirm that safe loan terms and sound underwriting—and not simply down payment or credit score—make the difference when it comes to loan performance.

Now that the Johnson-Crapo housing finance reform bill appears to have stalled in the Senate, responsibility rests squarely on FHFA to foster a healthier mortgage market. Last week’s announcements were a good start, but the agency has much work ahead to ensure that all qualified buyers in all parts of the country have a shot at sustainable homeownership.

Sarah Edelman is a Policy Analyst in the Economic Policy department at the Center for American Progress. Julia Gordon is the Director of Housing Finance and Policy at the Center.